An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date. The predetermined price at which the option can be exercised is called the strike price or the exercise price.
An option buyer is a person who gets the right to buy options. If the option buyer buys the underlying asset he is the buyer of a call option. If he sells the underlying asset he is known as a buyer of a put option.
The option seller is a party who has the right to perform if the option is exercised and charges the premium for granting such privilege to the buyer. The option seller is also known as an option writer.
Options are the contracts that carry the right to buy or sell an underlying asset at a predetermined price, size, and date in the future. One option transaction implies an agreement between two parties.
European options: An option that can only be exercised at the end of its life, at its maturity. Compared to European options American options can be used at any time of the end of an option.
American options: An option that can be exercised anytime during its life. American options allow option holders to exercise the option at any time before and including its maturity date, thus increasing the value of the option to the holder relative to European options, which can only be exercised at maturity.
Income received by an investor who sells or "writes" an option contract to another party is called a premium price. In case if the sold option hasn’t been exercised during a transaction the premium shall not be refunded to a buyer. Factors such as the price and volatility of the underlying instrument, current interest rates, and the amount of time left before the option expires also affect the premium price.
The strike price is defined as the price at which the holder of an option can buy (in the case of a call option) or sell (in the case of a put option) the underlying security when the option is exercised.
The last day that an options contract is valid. The option expiration date is the date on which an options contract becomes invalid and the right to exercise it no longer exists.
The option buyers or sellers have 3 alternatives as long as the expiration date is valid:
To sell the option contract they have bought;
To exercise the option;
They do not have a right to exercise the option and wait until the expiration date, there is a possibility to lose an option premium as a result.
The sold (written) option contract may be bought or sold again and therefore the deal between the parties will come to an end.
In case if the options seller wants to use his rights, he can implement his obligations.
In case if the option buyer who buys the option before the expiration date doesn’t use his rights he may get a profit in size that is equal to the option.
Call Options :
An option contract that gives the holder the right to buy a certain quantity of an underlying security from the writer of the option, at a specified price (the strike price) up to a specified date (the expiration date). The seller (or "writer") is obligated to sell the commodity or financial instrument to the buyer if the buyer so decides.
Put Options :
An option contract that gives the holder the right to sell a certain quantity of an underlying security to the writer of the option, at a specified price (strike price) up to a specified date (expiration date). The seller (or "writer") is obligated to buy the commodity or financial instrument from the buyer if the buyer so decides.
TYPES OF OPTIONS
A stock option is a contract between two parties in which the stock option buyer (holder) purchases the right to buy/sell shares of an underlying stock at a predetermined price from/to the option seller (writer) within a fixed period.
An option that gives the owner the right to buy or sell the specified amount of foreign currency at a specified price before or at the end of a determined date. Currency options are one of the best ways for corporations or individuals to hedge against adverse movements in exchange rates. Speculators who earn a profit on price fluctuations are highly interested in currency options.
Interest rate Options
The value of these derivative contracts is based on interest rates. An investor taking a long position in interest rate call options believes that interest rates will rise, while an investor taking a position in interest rate put options believes that interest rates will fall. A stock option buyer can assess available funds at low-interest rates status and benefits from high-interest rates while exercising the option at the markets.
A futures option, or option on futures, is an option contract in which the underlying asset is a single futures contract. The buyer of a futures option contract has the right to assume a particular futures position at a specified price (the strike price) any time before the option expires. The futures option seller must assume the opposite futures position when the buyer exercises this right. In other words, when the option is exercised the owner of the futures contract becomes an owner of the operation carried.
Option buyer/seller by paying the option premium becomes an owner of the option. The maximum profit is limited to the put premium received and is achieved when the price of the underlying is at or above the option's strike price at expiration.
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